25 AUGUST 2009


We’re still 4-6 months off of what we think will be a meaningful step-up in retail M&A. But this week’s mini-round of asset sales are definitely notable – especially for those ‘investors’ that barked at the Charlotte Ruse Board for not accepting a single digit bid 82% ago.



It’s hardly a secret that M&A has picked up across the board in almost every sector. But have you noticed that on a relative basis Retail has not participated? It started off strong earlier this year, and M&A over the past few months has pretty much died down to a crawl. My view on this has been, and continues to be, that retail, in aggregate, does not NEED to sell assets right now due to the cash flow stability and visibility presented by a) stabilizing top line, b) tight inventories, and subsequent gross margin predictability, c) sg&a cuts and d) capex cuts. My extremely strong view is that the M&A ante will pick up in 1Q10 when we see who will prove to have invested properly today in proactively driving their models, instead of milking the margin structures for all it’s worth (i.e. printing too much profit today and risking growth and cash flow stability next year).


With all that said, I was definitely surprised by yesterday’s announcement that Advent International is purchasing Charlotte Russe for $17.50/share or a total of $380 million. Recall that in November of last year, the company’s largest shareholder at that time attempted to take over the company for $9.50 per share- a bid that the board rejected, and many major shareholders openly dismissed. Now we’re looking at a price 82% higher for a sub-par business. Here’s a great example of a severe duration mismatch between those that rented the stock last year versus the Board of Directors.


Other M&A Callouts


  • Speaking of M&A, fashion blog “Fashionista” is suggesting that DKNY is up for sale by LVMH. The blog goes on to suggest that the brand is no longer a good fit with the company’s super premium/luxury strategy. While this is certainly noteworthy and something to watch, it’s probably more interesting that the story was broken in a fashion blog. It’s only a matter of time before trolling Facebook and Twitter will yield tangible investment ideas.


  • Nike is looking to sell its 100% stake in the United Soccer Leagues (U.S.L), a legacy position it acquired along with the company’s purchase of Umbro in 2007. The relatively unknown league has teams in the US, Canada, and Puerto Rico. Finding a buyer for the non-core asset however, may be more of a challenge. The most obvious buyer would be Major League Soccer (M.L.S), U.S.L’s biggest and more popular competitor. However, the M.L.S has chosen not to submit a bid for the league, which is likely due to potential anti-trust issues as well as the fact that the official sponsor of M.L.S is rival Adidas.





-Price is even more of a factor than last year for buying sporting goods and athletic footwear and apparel - Following on a study conducted last summer by The SportsOneSource Group that indicated that price had become the number one motivating factor in determining where to shop for sporting goods or athletic footwear and apparel, it comes as no surprise that the factor has become even more important this year.  The interesting point is how high product quality was ranked by consumers and the increased importance of convenient locations. An even higher percentage of adult consumers viewed Price as the most important factor when deciding where to shop versus the 2008 report.  Product Quality was the attribute ranked second highest and Product in Stock was the third ranked attribute. <>


-Lower production costs in inland China drive plants to move away from the coasts of Guangdong  - In view of the lower production costs in the inland region, Chinese leather and footwear processing are moving out in large number from the coastal belt provinces of Zhejiang and Guangdong. This is due to the ever-soaring labour costs and increasing investments in complying with the country's new environmental policies, while inland provinces such as Chongqing and Fuxin, received assistance from the local government, have been building industrial zones where offer factories comparatively lower land prices, labour, raw materials, water and electricity and modern sewage treatment systems. Exports and imports from the leather sector have dropped by 10.8% and 17.7%, respectively in June 2009. <>


-Margin Boost: brands and retailers are getting the cheapest shipping rates anyone has seen in a while - Brands and retailers are enjoying some of the lowest ocean freight rates they’ve seen in years and are likely to see only slight increases going forward. It could take several years for the world’s major ocean carriers to dig themselves out of an oversupply issue that they spent the last decade or more creating. Prior to 2007, rising global economies and booming Chinese manufacturing capabilities spurred a binge of ship and container building. The number of 20-foot equivalent units, or TEU, handled by the Port of Los Angeles alone went from 1.7 million in 1998 to 8.5 million in 2006.  <>


-Congress attempting to pass a bill that will raise manufacturing costs in order to create a more green environment - Greenpeace has been trying to push a bill at the US Congress that requires chemical plants to adopt environmentally friendly and safer manufacturing process. In the meantime, the organization has recently protested in front of a textile chemical plant against its use of chlorine gas in its manufacturing process which might cause danger to the nearby community. If the legislation is passed, safer technologies can be enforced throughout the country. A spokesperson for the National Association of Manufacturers termed the bill "regulatory overkill". <>


-Textile and apparel manufacturers in Hong Kong and China which export to the EU could face obstacles in the coming years - Further requirements of a tough law on chemicals and their safe use will have to be considered in relation to their products from 1 June 2011. While these stringent requirements set out in Regulation 1907/2006 (REACH Regulation) are not limited to the textile and apparel sector, given the significant amount of textiles and clothing exported from Hong Kong and the mainland to the EU, an early warning is particularly important. <>


-Under Armour will be sponsoring five New York high school basketball teams - UA will sponsor 5 NYC basketball teams as part of 27 high school basketball teams it will sponsor during the 2009-10 season, according to a report in the Daily News. That list includes Lincoln High, which has won seven of the last eight PSAL championships.  <>


-Warnaco names David Cunningham as president - Apparel maker Warnaco Group Inc. said Monday it named David Cunningham as president of its Calvin Klein Jeans division, replacing Janice Sullivan, who is leaving the company. Cunningham joined Warnaco in 2006 as president of the Chaps business. Before that, he was group president for Kenneth Cole at Paul Davril Inc.  <>


-Timberland Co. appointed Jim Davey as vice president of global marketing - Prior to joining Timberland, Davey spent eight years with Nickelodeon and Viacom Consumer Products, most recently as senior vice president, global marketing, planning and retail development. <>


-Lowe's Bets on Australia Property Market in Woolworths Hardware Venture - Lowe’s Cos., the second-largest U.S. home-improvement chain, will team with Woolworths Ltd. to enter Australia’s A$24 billion ($20 billion) hardware market, betting on an economy where home-building approvals rose by the most in four years. <>


-Whole Foods attempts to quell boycott cries - Protesters and unhappy customers have taken to the streets and to social networking sites to express their displeasure regarding Whole Foods chief executive John Mackey's recent Wall Street Journal op-ed column. Some are threatening to boycott the store altogether. The column, which appeared on August 12, was critical of President Obama's healthcare plan. It urged the country to embrace a more free-market healthcare system. Yesterday, members of the Washington D.C.-based United Food and Commercial Workers Union demonstrated outside of Whole Foods' stores in two locations in Ohio and plan to continue disseminating educational flyers to shoppers over the next few weeks. The group has emphasized the incongruity between Mackey's assertions and the brand image that Whole Foods has built. Online, the playwright Mark Rosenthal's "Boycott Whole Foods" Facebook group now has over 26,000 members. Though Whole Foods' own Facebook page has comments from numerous supporters stating their solidarity with Mackey and commitment to their local stores. <>


-Strong online sales growth in July - Online sales were helped by strong fashion sales and wet weather in July with customers spending £4.2bn, an increase of 16.8% on last year. <>


Thieves stole a semi-trailer full of footwear from a Wolverine Worldwide's distribution center in Howard City - Police say the thieves used their own semi-truck to steal the 40 foot long semi-trailer Monday morning. The trailer is said to have been full of footwear at the time it was stolen. Officials say the semi-trailer is is grey in color with "MAERSK" written along the side. <>


-LVMH wins trademark battle - A federal judge last week awarded more than $400,000 in damages to LVMH Moët Hennessy Louis Vuitton in a five-year-old trademark case over its Epi Leather trademark. The luxury house filed the suit in January 2004 alleging Carducci Leather Fashions Inc., a New York retailer, had sold counterfeit handbags bearing Louis Vuitton trademarks. As the case proceeded, however, the company discovered another firm, Bonini Italian Handbags Inc., supplied the items and added it as a defendant. Louis Vuitton and Carducci settled in 2006. According to court documents, Bonini never answered the allegations and the court eventually entered a default judgment against the company. <>


-Tiffany & Co. won a dispute over the sale of its Little Switzerland  business - A federal judge last week affirmed a $3.6 million award that Tiffany & Co. had won at arbitration in a dispute over the sale of its Little Switzerland Inc. business. Tiffany and NXP Corp., which bought the Caribbean jewelry chain through its Oakland, Mich.-based assignee Dhirim Inc. in 2007, had fought over the final sale price because of balance sheet adjustments. The two companies entered arbitration, as called for in the purchase agreement. In April, an arbitrator at financial services firm KPMG decided in Tiffany’s favor and awarded it $3.6 million. Dhirim refused to pay and, several weeks later, brought a lawsuit in U.S. District Court in Detroit seeking to have the award vacated.  <>


-Black Halo, a contemporary women's clothing line, has launched its first marketing campaign - includes photo ads in the September issues of Elle, Nylon and Interview magazines. The campaign, via Sew Branded in New York, was developed in late July and the beginning of August after the company held a photo shoot in order to update its Web site. This led Black Halo to venture into e-commerce, which in turn led to the decision to advertise. "It just made sense," said Sean Pattison, vp at the clothing company. What began as a simple project "took on a life of its own," he said. By advertising in fashion magazines, the company is looking to create "greater brand awareness for the general public," Pattison said. Black Halo ads will also run in the October and December editions of Nylon as well as the October issue of Interview. <>


-Spring Preview with The North Face - The North Face is freshening things up for spring ’10. The San Leandro, Calif.-based brand has updated its running and trail running styles (including a faster, more athletic look and a revamped logo) and is debuting two new eco collections with the men’s Kyoto and the women’s Suzy Qzy, as well as an expanded focus on casual styles. But the brand, which ranges from $80 to $130 for most styles, isn’t abandoning its technical focus, with trail running and multisport styles making a strong showing. Styles from The North Face are available at outdoor and athletic shops, as well as select sporting goods and department stores. <>





TIF: Charles Marquis, Director, exercised the right to buy 11,856shs ($29k) adding roughly 10% to total common holdings.



  • James Johnson, Director, sold 2,528shs ($114k) or roughly 20% of total common holdings.
  • Troy Risch, Executive Officer, sold 1,478shs ($67k) upon the vesting of options approximately 5% of total common holdings.


BGFV: Jeffrey Fraley, Senior VP – Human Resources, sold 10,000shs ($141k) nearly 40% of total common holdings.


ALL reported weak results, but they came in at the high end of their guidance given in April.  An intriguing 3-5 year plan was outlined.




  • Double participation share in the US
  • Improve ship share in Australia
  • Reduce volatility in Japan
  • Focus the organization on key markets while exiting the low ROI markets





Commentary on 1H09 results:

  • Revenues were down 5.3% in 1H09 vs 1H08 (would be down 20% on a constant dollar basis)
    • EBITDA of 129.4MM was down 19% (or 31% on a constant currency basis)
    • Operating profit after tax was down 38%
    • Operating cash flow was up 15.8%
  • Operating results were at the top end of their guidance in April due to better results in rest of the world - especially South America
    • North America met expectations
    • Japan was the weakest region and performed below expectations
  • North American market conditions remain challenging
    • Sold 4,264 units into North America vs 5,252 in last yrs 1H
    • Decline in unit sales was 18.8%, conversions up 18.8%
    • Systems revenue was up 9% and services revenue up 10.3%
    • Over 10k Viridian units placed
    • Ship share was improved
    • Gaming operations        
      • Expect to benefit in the second half from higher install base and successful JAWS launch
      • We saw this product at Mohegan Sun yesterday and heard good things
  • Japan units declined from 32k in 1H08 to 5k units 1H09. Overall market volumes continue to be challenged by the weak economic environment
  • Japan – absence of major game releases caused poor results – only 5,747 units sold.  Australian dollar also weakened, which increased reported results
  • Australia is a challenging market but some signs are encouraging
  • Recurring revenue was impacted by lower win per day, partially offset by mix
  • Asia Pacific was negatively affected by limited openings, tough conditions in Europe 
  • New Zealand was up 210% (profit)  
  • South Africa and South America sales decreased by 14.4% and 30.6%, respectively
  • They are outsourcing more R&D to India



  • Expect market to remain challenged
  • Pricing holding up despite low volumes
  • North America will continue to roll up JAWS and introduce new games
  • Japan will release 2 license titles
  • Will focus on Veridian rollout internationally
  • 3 to 5 year phase strategy to deliver growth - no quick fixes
    • Need to focus more on the US – participation market especially
      • Want to double their participation share over the next 5 years
    • Games that are player led, technology driver
      • “customer centric” model and more strategic approach about managing IP
      • Faster, more focused product development – more outsourcing
    • Best Games, best system
      • Focus on server based
      • Grow their presence in US systems
      • Build a stepper business
    • More strategic market focus in terms of where they want to compete
    • World Class Organization
      • Right-sizing the business, cost cutting, stream lining the organization
      • More of the team based in North America
  • Australia – need to close the gap between ship share and install base (à la IGT in the US)
  • Japan – aiming to achieve 50,000 units sales per year in the future
    • Building pipeline of license characters which have more appeal than developed characters
  • Aim to exit 30 jurisdictions that aren’t profitable so they can focus on the markets with real opportunities like Spain, Macau, Mexico, etc
  • Accordingly, bottom line priorities are
    • Double participation share in the US
    • Improve the share in Australia
    • Reduce volatility in Japan
    • Increase focus and resources on key markets while exiting low ROI markets



  • Quantify cost savings on overhead?
    • 10-15MM in costs related to implementing the strategy (due to restructuring costs)
    • Next year they expect the strategy to be break even and then, going forward, CF positive
    • Targeting the run rate they achieved 1H09 to 2H09
  • Ship share in Australia was 33%
  • Moving management and R&D to the US?
    • They have three studios in the US and are looking to add more
    • They believe they have the best math
    • US market is just too important to “export” games to the US - need to develop US centric games
    • ALL plans to keep total R&D at current level – need to invest “smarter”
  • New markets in the US? Do they want more Class 2 presence?
    • ALL has not truly competed heavily in Class 2 before but is looking at it
    • The biggest opportunity is class 3 - IL & OH
  • Jaws – install base is up by 500 net on the games ops side (900 JAWS installed)
  • How will they increase their participation share? Who will they take out per say?
    • In 6 months they increased their install base by 10%
  • Japan – how confident are they that they can manage the volatility better – timing build out of pipeline of licenses?
    • Licensed games do much better than in-house developed games
    • There is a need for at least 2 licenses per year to hit their numbers – will take a few years
  • Trying to grow the revenue line without growing the cost line by right-sizing and having better focus
    • Getting best games out/speed to market – takes 12-18 months (especially for licensed games)… so it will take some time
  • Replacement market – still see the next 6-12 months as challenging
  • In North America – why did they just have flat prices vs increases at competitors?
    • ASP has usually been higher than competitors
    • 1H09 had a large # of corporate deals (PA) that have higher than usual discounting
  • How many steppers did they ship in 1H09?
    • They launched late in the half – so only 300 units
    • They don’t yet have enough content on stepper, but a good platform.  It is a whole new segment for them
    • Discounted the steppers
  • Japan – have they procured brands already?
    • Yes – have a number of licenses that they have procured – 6 potential launches for next year – 4 are licensed, 1 is a major license
    • Need to mature licenses, buy licenses that are more nascent and then develop them over time
  • Increased use of licensing is a theme in the slot business, how to quantify the impact on margin?
    • Licensing costs are a fee per day on hardware and software
  • New Zealand 1H09 results was driven by a regulatory change – so 2H09 won’t be as good
  • Mexico strategy?
    • Class 3 is now legal, they are in the process of indentifying product for that market
  • “Can’t save your way to greatness”
  • 1,300 of the games they sold were to new sites/expansions in 1H09
  • Have a number of stepper games on trial that they hope will be converted to sales
  • They don’t see improvement in North America at this stage


Martha's Depression

“Truth is what stands the test of experience”

-Albert Einstein


I suppose that it’s only fitting that Washington is going to stand up today from Martha’s Vineyard and tell you, with a straight face, that Ben Bernanke is the Almighty Savior for averting the next “Great Depression”. This has to be the hyperbole of the year.


Being the “expert” of everything “depressions”, you’d think that Mr. Bernanke would get the joke. With China running high single digit GDP, the US on the verge of reporting positive year-over-year GDP growth in Q4, oil and copper having doubled… these guys have to be kidding me.


Per Wikipedia, “a study by the Martha's Vineyard Commission found that the cost of living on the island is 60 percent higher than the national average and housing prices are 96 percent higher…”… nice place to tell America stories from, I guess. The only Depression I see at Martha’s is Dick Fuld no longer being able to show his mug there.


Storytelling and groupthink run rampant these days, so don’t get upset about the conflicted message embedded in America’s financial leadership. We’ve all been there and done that – just deal with it, have your own investment process, and capitalize on it. This morning’s marked-to-market reaction to the Bernanke re-appointment from the island retreat where alleged food bank lines are forming doesn’t rhyme with the Depression narrative.


Asia sold off across the board. This makes sense, because the losers here are America’s creditors. As Bernanke panders to a ridiculous notion that we are in a Depression and holds this country’s hard earned savings accounts at a zero percent “emergency rate”, the US Dollar continues to weaken. As the dollar weakens, the Debtors, Bankers, and Politicians get paid. The Chinese Creditor and American Saver foots the bill.


Some might argue that China sold off -2.6% because China Construction Bank (2nd largest bank in China) said there is excess cash in the Chinese banking system right now and they’d like to stave off asset bubbles (at least they admit it!). Some might argue that China was down because it was up a cumulative +7.2% in the three trading days prior. I wouldn’t disagree with either argument. Those, combined with America’s compromised currency, provide the collective wisdom of global macro crowds.


Of course, there are many other factors in macro this morning that sing a different tune than the blues of those staving off starvation at Martha’s this morning. Consider this non-fiction 3 factor reading list:


  1. The US Dollar is down another -0.1% to $78.21, testing another critical breakdown of the $78 line (which has only been sustainably broken once in the last 38 years)
  2. Israel RAISED rates to +0.75% and the Tel Aviv 100 Index shot up another +0.78% on the news (that market is up +64% YTD, and they don’t believe in ZERO rates)
  3. Spain is trading higher this morning after reporting the lowest levels of producer price deflation since 1976 (-6.7% y/y); Dollar down = Euro up = import EU deflation


Again, a Burning of The Buck that’s sponsored by a political Bernanke backboard of “he knows his Depressions”, is simply moving more and more capital away from the United States of America and to other markets in this world. The world is a large place.


Rather than qualify my investment opinion (I have learned the “not to do” part of that lesson the hard way), it’s more palatable in these days of increasingly interconnected global markets to just follow the money.


I am certainly no Jerry McGuire, but I can definitely show you the money. Yes, some of it is at Martha’s… but a heck of a lot more of it is on China’s balance sheet right now. As Bernanke panders to the politics of his job security, understand this: The Client (China) is watching.


Whether American politicians get this or not, foreign capital flows to country’s with positive rates of return. If you don’t want to believe that, ask someone in Japan what ZERO rates of interest do to attract investment.


This morning’s move by the Israelis is not unlike those that have recently been signaled by both the Australians and Norwegians. All three of these countries want to show in higher Fed Funds equivalent lending rates to both The Client (China) and their domestic savers. This isn’t complicated to understand. Unless you are still living the narrative fallacy of Martha’s Depression.


I said I was going to keep selling US Equities yesterday, and I did. US Equities now have the lowest allocation in our real-time Asset Allocation Model. I don’t have to recommend you keep your hard earned capital in a country that’s as conflicted and compromised in her monetary policy as America is. I don’t have to be perpetually bullish on US Equities. Everything has a time and a price.


My immediate term TRADE resistance for the SP500 is now 1034. A correction to the my immediate term TRADE support line of 1005 is as perfectly probable as Bernanke and Obama telling you they were the Americans who averted Martha’s Depression. Make sure you have some sunscreen on boys. The You Tube cameras are on.


Best of luck out there today,






EWH – iShares Hong KongThe current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.  


EWZ – iShares BrazilPresident Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt –leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country’s profile matches up well with our reflation call. 


QQQQ – PowerShares NASDAQ 100We bought Qs on 8/10 and 8/17 to be long the US market. The index includes companies with better balance sheets that don’t need as much financial leverage.  


CYB – WisdomTree Dreyfus Chinese Yuan The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.


TIP– iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis. 


GLD – SPDR Gold - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4. 






XLP – SPDR Consumer Staples – We shorted XLP on a bounce on 6/21. One way that investors chase a bearish USD is buying international FX leverage in global consumer staples. Shorting green.


DIA  – Diamonds Trust - We shorted the financial geared Dow on 7/10, 8/3, and 8/21. 


EWJ – iShares Japan – We’re short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.


SHY – iShares 1-3 Year Treasury Bonds – If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


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Eye on Vietnam: Notes From Ground Zero

Our COO and the head of our Hong Kong office, Michael Blum, recently visited Saigon and relayed to us some of his anecdotal thoughts from the trip.  As many of you know, Saigon, also known as Ho Chi Minh City, is the largest city in Vietnam with a population of 7,123,340, which is ~90% ethnic Vietnamese.  While the city accounts for only 0.6% of the land area and 7.5% of the population of Vietnam, it accounts for over 20% of the GDP.


Vietnam is still a relatively poor country with purchasing power of ~$3,300 per capita; it has also had one of the highest growth rates globally over the past decade.  The country’s primary industries are: manufacturing, information technology, and agriculture.  The country also has one of the most open economies in Asia with two way trade estimated to be ~160% of GDP, more than twice that of China and four times India.


Michael’s notes are below:


Saigon is bustling. The new Intercontinental Hotel, located opposite of the US Consulate, will open its 300 rooms in the coming weeks – a small hotel by most standards these days. Yet in Saigon, they are much needed, even though the country’s economy has seen a rollercoaster ride since I last visited in early 2007. The manager of a nearby 5-star hotel says to me:  “Under normal circumstances, the competition might depress occupancy but there is a lack of luxury rooms in Saigon – I’m not expecting any adverse impact on my business.”


Traffic around town is at a point where getting from A to B is a challenging task. The city is known as the world’s capital of the motorbike. Everybody seems to be up-grading their motorbikes to newer, bigger and better models – even the old lady has traded her bicycle in for a motorized version. The local BMW dealer is doing well and I hear that the newly affluent class has taken a fancy to Harley Davidson.


While inflation has hit the local population very hard, Saigon has become much more commercial, more colorful and more international and the population has grown. All of the international fashion brands are now present. There are cafes everywhere, small stores crowd every inch of street front property and upscale restaurants do very well. Just a few years ago, they were quiet refuges. Now, reservations are essential. And everyone wants to get paid in USD – even though technically illegal unless you are a specially licensed 5-star hotel – to have a stable currency against the 30+% inflation of the Dong.


Yet for the expatriate community here, however small it may be, Saigon is a boring place. “There is no theater, no ballet, no opera. We only recently got a somewhat nice movie theater but it doesn’t show many movies from overseas. A concert by an international performing artist is unthinkable.”


An overseas Vietnamese contact of mine, who returned to Saigon 9 years ago explains: “There are only two things the Government still controls: access to land and culture. If they let go of either, their days are numbered. They know this and so it will never happen – the last instruments of power.”


Saigon’s first luxury condominium tower is going up not far from the Opera House near the Saigon River. At US$8,000 per square meter, the developer will start selling units in the coming weeks – the highest price ever achieved in Vietnam. Two years ago, they would have gotten bribed by buyers to get access to a unit. In this market, they expect to sell out – “but it will take a few weeks work.” Target market: The newly affluent generation of Vietnamese. One of the partners tells me: “You can’t invest in Vietnam based on the math that works elsewhere. We looked at various pieces of land 10-years ago. The prices were so high, we could not justify the investment. No matter what we would have bought then, today’s price is at least 10x higher. Had we built this tower in Singapore, we would probably achieve just short of US$20,000 per square meter. But GDP per capita in Singapore is well over US$30,000, here it is right only around US$1,000.”


The stock market crash has also taken its toll. No one has raised any money in recent memory to invest in Vietnam I am told. Many local funds had to fire large portions of their staff or close down. Even the most renowned investment firms were at the brink of collapse. But the market has rallied 50% this year. Can it do more? Everyone hopes so – the fall was a steep one.




Daryl G. Jones
Managing Director

Slouching Towards Wall Street… Notes for the Week Ending Friday, August 21, 2009

The China Syndrome – Are ETF Investors Buying A HOG In A Poke?




Ready To Rumble? – ETFs: How Not To Regulate




Intelligent Design


If we did ten things, and nine were bad and were disclosed by the newspapers, we would be over.

          - Mao Zedong


Invesco, the managed money giant with a reported $403 billion under management, is well known for its PowerShares ETFs.  Under their registered promotional announcement, according to their website, they are “leading the intelligent ETF revolution.”  Just how “intelligent,” we are now finding out. 


We have been casting about for a fitting metaphor for ETFs.  Now we believe we have one: ETFs are the financial markets equivalent of Intelligent Design.  Intelligent Design proponents bamboozle their way into the dialogue through the ruse of misappropriating a term of art, and repackaging it in its common usage.  They say that the Theory of Evolution is “only a ‘Theory’”, which therefore must be forced to yield the floor to other “Theories.”  By taking the word Theory – used in its scientific meaning as a commonly-accepted mechanism which, though perhaps not fully understood, is widely agreed to contain basic truth about how a phenomenon works – and putting it into its common usage, where it means “something we’re not quite sure about at all, but we hope it might explain some of what goes on”, they undermine the debate, grab headlines, and so far have managed to come perilously close to forcing their will on the nation.  The fact that they manage to be taken as serious debate partners at all is a testament to the rampant ignorance of a nation that would rather read Twitter than Dickens. Not that we are measurably worse in that department than most other cultures – but this happens to be the culture in which we live, work and pay taxes, and so our country’s foibles strike closer to the heart.


In a parallel testament to the ignorance of the investing public, and of those charged with protecting them, ETF issuers have achieved the mass retailization of a sophisticated institutional product, right under the noses of the regulators.  Gee, who’d a’ thought?


These are “Funds” that “Trade” on an “Exchange.”  That makes them securities.  And since they trade in units called “Shares”, and since their shares trade on exchanges and are bought and sold in a two-sided market, they are really just like common stocks.




In a rare and marvelous exercise of backwards-think, the regulators managed to convince themselves that ETFs walk like anything but a duck.  Rather than viewing ETFs as a single-share unit instrument that actually comprises a synthetic contract used in sophisticated, algorithm-driven arbitrage programs, regulators have benignly treated ETFs as nothing more than misunderstood common stocks.  The investing public was duly led to the trough, with the result that a fair number of them have been scratching their heads at instruments that appear to be tracking something very different from the indexes they were supposed to be tied to.


Now, just when we thought we had seen it all, our detector has come across yet another potential land mine in the investors’ portfolio.  (Actually, we do not think we have Seen It All.  The creativity and genius of even minor scam artists is astonishing – to say nothing of the frenzied gullibility of the investing public, who literally have wagered their own lives and the lives of their children yet unborn on nonsense as diverse as tulip bulbs, international postage coupons, and Bernie Madoff’s decades of “too good to be true” steady market-beating performance.)


A product which may be far more “revolutionary” than Invesco realized is the PowerShares Golden Dragon Halter USX China ETF, a mouthful whose ticker symbol is PGJ.  Launched in December of 2004, the fund seeks to replicate the return “of an equity index called the Halter USX China index(SM). The fund normally invests at least 80% of total assets in equity securities of companies deriving a majority of their revenues from the People's Republic of China.”  (Yahoo! Finance)


The Halter China Index was created by Tim Halter, head of Halter Financial Group.  This fact was not immediately obvious because the website for Halter Financial does not feature a drop-down titled “Management”.  Indeed, we searched in vain for anyone’s name on the website.  We admit to being technologically behind the times, and impatient to boot, but it struck us as odd that the founder of a firm that bears his own name would not feature himself prominently on his own website.


Another odd item: Halter’s website has two URL addresses.  One is “”.  The other is “”.  Halter has built a specialty niche business taking Chinese companies public in the US market by merging them into public shells.  They have even trademarked a concept they call the Alternative Public Offering – a combination of a reverse merger and a PIPE capital raise.


So far, so creative. Halter’s website describes their on-the-ground approach to Chinese investing – they opened an office in Shanghai in 2002 – and proudly lists the companies they have brought into the public marketplace in the US.  A peruse of this list, cross-referenced through Google, turns up one or two tidbits that we found curious.  We hasten to point out (our lawyers will like this) that we are not accusing Halter of any impropriety.  But the structure of their fund raises potentially troubling questions for ETFs in general.


Among the quaint features that emerge is an apparent nexus between Halter’s activities and a gaggle of smaller Texas businesses (Halter is based in Dallas) including a leather factory, a building contractor, and a female bodybuilder who is apparently somewhat successful on the local circuit.


In September of 2005, Strong Techincal, Inc filed an SEC Form 424B3,  disclosing that Halter Capital Corporation had acquired a controlling interest in Strong’s shares (82.4%) and that all previous business activities of Strong Techincal were discontinued, thus creating a public shell.


That company – renamed Zhongpin – now trades on the Nasdaq under the symbol HOGS.  Yahoo! Finance reports it closed on Friday 21 August at 11.37, down fractionally on the day, on volume of over 255,000 shares – late-August trading no doubt partly responsible for the volume coming in substantially shy of their three-month average of over 326,000 shares (all data taken from Yahoo! Finance).  The Top Mutual Fund ownership data available lists PowerShares Golden Dragon Halter ETF as number eight out of the top ten fund holders of Zhongpin shares.  The position shown on Yahoo! is only 79,000 shares, or 0.29% of the total outstanding.


We wonder about the activities of a financial firm that takes Chinese companies public through reverse mergers, then puts those same companies into an index it manages, which may automatically require those shares to be purchased by an ETF tied to its index.  ETFs are required to post positions, but not all of them.  The prospectus we found on the PowerShares website lists the top 30 positions in the Golden Dragon ETF (ticker PGJ).  Needless to say, at a market value of some $650,000, PGJ’s position in HOGS is not material to either HOGS itself (market cap in excess of $330 million) or to the ETF.  Neither HOGS nor PGJ, with reported assets in excess of $383 million, will not feel a ripple from a fluctuation in a position of that size.


On the other hand, due to the opacity of the lower capitalization end of the ETF structure, we have no way of knowing how many of Halter’s own reverse mergers may be held in the ETF managed based on its index.  Membership in Halter’s China index requires only a $50 million market capitalization.  This permits highly illiquid securities to be included in the Index, and thus bought for the ETF.  A quick comparison of Halter’s own website – which lists tombstones for a number of their deals – with the Halter USX China Index website reveals that a number of the companies held in the Index were Halter deals.


As we have previously noted – see last week’s discussion of natural resources ETFs – creation and liquidation trades rely on instant liquidity.  It is entirely possible that a fund such as Golden Dragon would seek to satisfy its liquidity requirements by trading the top tier of its most liquid stocks, while not touching the essentially illiquid shares in its basement.  Indeed, selling out of stock for which there is not a sufficient bid might be deemed not in the interest of shareholders of the fund.  Thus, if Halter were in fact to put their own illiquid reverse merger stocks into their Index – and they were then bought into the ETF – this could have the effect of permanently locking away a portion of the float.  Or of creating liquidity for sellers in an otherwise illiquid market.


In any event, the fund would likely not be out of those positions for long.  The Golden Dragon ETF’s assets appear to have climbed substantially this year as China gained investor visibility.  Our very inexact eyeballing of their figures indicates their assets are up by more than a third since the first quarter.  An insignificant million-dollar trade for a fund approaching $400 million in assets could have a meaningful impact on the shares of a company with only $50 million in capitalization.


We are hardly the first ones to note this phenomenon.  An article appeared in Barron’s a couple of years back (28 October 2006, “China Funds’ Shell Game”) which contains the following paragraph:


“Barron’s review of the index unearthed conflicts that ought to give fund investors pause.  The shares of at least one of these companies rose in value after entering the index, but as the stock gained, Halter and his family were selling.”


For all the digging Barron’s claims to have done, the article makes for fairly tepid reading and fails to come up with a smoking firecracker.


Frankly, while we are mindful of the potential for abuse in a set of small, interconnected businesses, we would rather not see regulators spending inordinate amounts of time going after the Halter Financials of the world.  While we have no concrete evidence to suggest they are doing something they should not, the fact that they have rolled into their own Index shares of companies for which they were the banker, and that those shares are now bought by an ETF based on that Index, doesn’t pass our smell test.


A read through the PGJ prospectus, available on the PowerShares website, does not mention that Halter is the banker for a number of companies held in the Index.  If, as Barron’s indicated, there are Halter personal or family holdings of any of these issues, it appears not to be disclosed.


We believe all this to be legal, by the way, which is an indictment not of Halter and their business, but of a legislative and regulatory regime that actively promotes the cloaking of critical information. 


Indeed, Halter Financial may legitimately have a different problem, which is the appearance of conflict of interest by virtue of having succeeded.  If, in fact, they really did set up a Shanghai office, get to know local businesses, gain tremendous insight into the Chinese economy and marketplace, win the trust of local business leaders and government officials, and create an unassailable niche in the US securities markets by bringing Chinese companies public with a minimum of expense – if so, then Halter may be a victim of their own success.  If they have in fact done all this, Halter may be the only firm that truly understands its markets.  If so, they may find themselves faced with a dilemma: to put their own companies into their Index – trading names they know intimately – or step back from that and go with lesser quality issues.


If so.  And if not…


The SEC and Congress are apparently not troubled by the fact that investors can take a shot on an index, while simultaneously creating liquidity for entities with an undisclosed direct interest in that index.  Undisclosed, we repeat, because it is not required to be disclosed.   We wonder what lessons PGJ’s bigger siblings have drawn from this.  We fear the flap over the CFTC wanting to limit commodities trading by ETFs may be the tip of an iceberg – and the wrong iceberg, at that.  We invite the CFTC to look into links between ETF managers, the traders who fill their orders, and the downstream interests that stand to gain as contracts or physical commodities are bought and sold.


We would invite FINRA and the SEC to do the same – except they have clearly already looked at this structure and determined that everything’s cool.  ‘Cause otherwise, well you just know they would do something about it.


Intelligent Design?  We call it downright Brilliant.




Dumb Design


I have a very strict gun control policy: if there’s a gun around, I want to be in control of it.

                   - Clint Eastwood


Followers of market statistics have noted a record divergence between the price of oil and that of natural gas.  This week, market watchers were also treated to the news that “A hedge fund has made a large, eye-catching bet that natural gas prices will triple…” (Financial Times, 20 August, “Fund Bets Millions On Tripling Of Gas price”).  Taking a moment to parse this story, we wish to point out that the purchase of six month, out of the money call options does not mean that the buyer is betting gas prices will reach or exceed the strike price.  For a newspaper of the stature of the FT to suggest otherwise is sloppy reporting, at best - or fear mongering (could the FT be long natural gas?).


That being said, we think it worthy of note that someone is scooping up January and February contracts at the same time that the CFTC is clamping down on ETF trading in the underlying commodity. 


As we have predicted, the price of the natural gas ETF – the now notorious UNG – has diverged sharply from the underlying commodity.  The Wall Street Journal (22 August, “Small Investors Face Big Hit In ETF Push”) reports “UNG is trading at a 16% premium to gas futures because investors are willing to pay extra for the ability to expose their portfolios to the commodity.”  The article quotes UNG as stating they already own “about a fifth of certain benchmark gas contracts.”


The same WSJ article discusses the CFTC’s stated objective of protecting end consumers of the commodities in question.  Restricting ETF access to these markets will have the effect of raising expenses within funds, even as their investable asset base becomes limited to funds on hand.


The Journal article points out that these once-proud ETFs will then trade more like closed-end funds which, as the article says, “would render the instruments less desirable, because prices of the shares of closed funds tend to deviate from price moves in the underlying commodity.”


How are the mighty fall’n!


It would appear that, in their zeal to protect the consumer (read: the people buying natural gas for industrial use) the CFTC is whacking the consumer (read: the people who invest in ETFs for portfolio diversification, or as a commodity hedge against stock market declines).


Enter CFTC commissioner and long-time Washington pro Bart Chilton.  “The Commission has never said ‘You aren’t tall enough to ride,’ Mr. Chilton said.  “I don’t want to limit liquidity, but above all else, I want to ensure that prices for consumers are fair and that there is no manipulation – intentional or otherwise.”


This has all the makings of a World Wrestling Federation Smackdown Tag Team free-for-all.  In one corner, the Feds are fighting amongst themselves over who gets to regulate the markets – like in the world of pro wrestling, being on the same team doesn’t mean you don’t also make it with each other’s guys when the other woman’s back is turned.  CFTC Chair Gensler is applying the hair-pull to SEC Chair Schapiro, stepping up to regulate the untamed ETFs – which, since they are “shares” that “trade” on an “exchange” might actually be the bailiwick of the SEC, watchdog of the securities markets.


In this corner, the ETF industry – a team of musclebound giants who always charge their opponents in unison.  They never bother to tag up, they just all jump into the melee together.  When you are that big, the referee doesn’t challenge you.


Stuck in between all this sweat and spandex and steroid-generated muscle, the investor is staggering dazed around the canvas.  We may not be tall enough to ride, but we are apparently big enough to get tossed repeatedly from the back of what was sold to us a the gentlest horse in the stable.


Commissioner Chilton refers to “manipulation – intentional or otherwise.”  We always thought that manipulation required intention.  We carry no license to practice law, but we think if ou are a victim of your own success, then you keep taking advantage of market inefficiencies until you – or someone else – chokes.  Then, goes the theory, the inefficiencies go away and you have to come up with something else.


If it is “otherwise” – i.e. not intentional – then it is not manipulation.  For a senior regulator to make such a clearly false statement looks like a danger signal.  The CFTC is not out to regulate improper, or excessive trading in the instruments it oversees, but is out to “fix” the marketplace.  This, of course, is the ultimate in manipulation.  


Still, we recognize that Chairman Gensler is in a bind.  The SEC won’t do its job of unknotting the relationships in the ETF world, to make sure the engine runs clean.  The SEC can not step in and regulate the commodity or futures markets, and they apparently will not force full and transparent disclosure on the ETFs, nor have they acknowledged strongly enough the fact that ETFs frequently do not do what they are supposed to.


Investors can not clean up the market.  The theory of market efficiency presupposes that someone out there wakes up one day and recognizes that things are not working out as advertised, but surely we all recognize that it doesn’t work that way.  With fifty million adult Americans functionally illiterate – and with the ones who can read working either on Wall Street or in Washington – it should be clear by now that this B-School theory looked great on paper (assuming you were one of the minority of Americans who could actually understand what it said), but that it won’t work in reality.


Gensler, Schapiro, Chilton et all – they all have their political masters to serve.  We are not worried about Gensler – a former Goldman partner – and Chilton has deep roots in both the farm lobby and the Washington establishment.  Neither of these gentlemen will worry about where their family’s next meal is coming from.


Chairman Schapiro, on the other hand, still has a tough row to hoe.  She constantly risks being tarnished with the Madoff brush, should anything big come up on her watch – and she’s getting precious little help from the Obama Administration.  Rather than standing up to Congress and making them give the SEC substantial new resources, President Obama appears to be using Schapiro to advance a political agenda aimed at giving trade unions the ability to interfere directly in the management of companies they work for.  We thought one shareholder, one vote was a fine idea.  The problem is that, when pitting the labor unions against entrenched boards of directors and mega-star CEO/Chairmen, it is difficult to ascertain who is more corrupt and less capable ofr actually making an intelligent business decision.


While all this is going on, the financial titan tag teamers continue their time and continue to suck up assets until the Next Big Thing comes along.  By the way, once ETFs are no longer the flavor of the month, bet on all the big managers filing to change their fund structures.  This will no doubt be a satisfactory solution and will be announced as a triumph for the investor.  The best way to make bad securities go away is to pass a law saying that they are now good securities.  This will get the masses to put down their pitchforks for at least a fortnight, and serves the politically important end of making it look like the SEC and CFTC have accomplished substantial change, without either entity actually having done anything.  We watch for ETFs to start to convert to some now fund structure, with the joint blessing of the SEC and the CFTC.


Meanwhile, this monumental brawl looks even less like WWF Smackdown, and more like a desperate barroom fight where someone has dropped a pistol.  Everyone is clutching at the gun.  Sooner or later, it’s bound to go off.


Moshe Silver

Chief Compliance Officer


Chart of The Week: Monkey See, Monkey Do...

I get a tremendous amount of feedback (mostly positive) about staying with this important macro call that we established in Q2. Initially we coined it Breaking The Buck. In Q3 we changed it to Burning The Buck (we update our 3 core Global Macro Themes quarterly).  I understand that macro inverse correlations like this aren’t perpetual. But they sure are profitable while they last.


In the chart below, Andrew Barber and I have shown what the last 7 weeks have looked like from the perspective of this simple 2-factor setup (SP500 versus the USD Index). For economists, hindsight like this is always crystal clear – but we wanted to show it in to your inbox this morning so that you can put it in front of the next economist/strategist that comes into your office and tells you this can’t be this simple.


In chaos theory, you take a dynamic/complex system and find deep simplicity in underlying patterns. That’s all this is – its math. As soon as the crowding out effect starts to erode the returns associated with a US Government sponsored Dollar devaluation, I will change my stance. For now… Monkey see, Monkey do…



Keith R. McCullough
Chief Executive Officer


Chart of The Week: Monkey See, Monkey Do...  - sp11


Chart of The Week: Monkey See, Monkey Do...  - sp22



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